Skip New Puerto Rico Bonds, Better Value Elsewhere in PR – Citi

By Michael Aneiro

Citi‘s muni strategy team today examines the $3.5 billion in new bonds issued by Puerto Rico last week, comparing them to Puerto Rico’s outstanding bonds to see which look like the better value:

To analyze the fair value of the new PR bond, we consider five factors that substantially differentiate the new deal from the rest: a) dollar price, b) tax cost, c) price of embedded par call, d) deal size, and e) jurisdiction. Estimating the effect of all the factors above, we believe that the new GO deal should trade about 60bp cheap to outstanding long-dated GO bonds, compared to 115bp currently, leaving enough room for price appreciation.

Speaking of room for price appreciation, those new bonds, which were issued at 93 cents on the dollar and traded as high as par last week, are trading back down around 94 cents on the dollar today, according to the MSRB’s EMMA website.

Even if the new general obligation bonds look better than the old ones, Citi says there are better values to be found if you look at Puerto Rico’s non-GO bonds:

PR GOs rallied by 163bp in 2014 outperforming the rest of the muni market by a large margin. For example, investors could take a look at PREPA and COFINA subs, which, in our view provide a much better value than GOs in the current market environment. PREPA bonds with similar coupons and maturities trade 158bp cheap to GOs, while COFINA 2nd liens are effectively trading flat to GOs – both bonds were trading substantially through PR GOs last year.

We also feel that PR’s curve could continue to steepen as near-term liquidity concerns subside, and recommend adding exposure to short / medium-term bonds. In general, we feel that a lot of good news is priced in PR spreads at current levels, and, in our view, the Commonwealth has a lot of challenges ahead to overcome. In our view, PR yields are currently relatively close to fair value, but given their outperformance going into the deal, we think that the rest of the muni market should perform better going forward, and recommend for investors to look elsewhere in the muni HY space for better opportunities.

Citi says it currently recommends overweighting the high-yield sector of the muni market, particularly tobacco bonds, water and sewer bonds and transportation bonds.